Learning From Failure

Sydney Finkelstein is the coroner of the business world: He examines the wreckage of dead or dying companies to find out what happened. The professor at the Tuck School of Business at Dartmouth is less interested in what executives do right, than in what they do wrong. Clearly, he thinks we can learn more from our blunders than from our triumphs. Finkelstein authored a book on the topic titled Why Smart Executives Fail. He sat down with Directorship to talk about how his studies can be applied to the current financial crisis and what we can learn from other people’s disasters.

So what are the main reasons that otherwise brilliant executives mess up?

One of the main drivers of failure that I found in my research is related to strategy, the assumptions that leaders make, and whether those assumptions are accurate or not. The reason I think it’s important to look at assumptions is that they are certainly something that boards can pay attention to and ask questions about. But also assumptions are, in some ways, the first principles of strategy.

Do executives tend to be overly optimistic in their assumptions? Do they fall in love with their own strategies?

There’s a natural tendency for all people to like to keep doing what they’ve been doing before if there’s been any degree of success in it. And sometimes if it hasn’t gone as well, they tend not to focus on some of those signals.

The world is changing and changing very quickly. My experience has been that not that many companies and senior executives are taking the time to say, “Well, are these assumptions that we put in place and are driving our strategy still relevant? They’ve been around for six months or a year or whatever their time frame might be. Are they still operative or has the world changed so much that we need to adjust?” These are exactly the questions a board member can ask: “What are the assumptions?” and “How do you know they’re still accurate?”

We hear all the time that the pace of change is speeding up. How true is that?

I think the best evidence that the pace of change is increasing, really accelerating, is to just look at the example of the companies in the Fortune 100. From 1955, when the list was started, to 1965, 80 of the 100 were still on the list. By 2005, there were only 18 of the top 100 still on that list. And from 1995 to 2005, 30 companies dropped off. That’s a huge attrition rate, and it has continued.

Are some of these companies blinded by their own success?

That’s another reason for failure that I call “the delusions around a dream company.” It refers to a successful organization, one that’s been hitting the numbers, but suddenly goes into decline. Because of its success, management begins to believe that it doesn’t have to pay as much attention to what’s going on around it. Executives begin to believe that they are the cause of success because they are so good. And what happens in those situations is really a lack of debate and discussion. This is absolutely what was going on at Enron. It was hitting the numbers, blowing past the numbers, and growing into one of the largest companies around—just a powerhouse. In part, because of the tremendous success of what was going on, the board got complacent. We have learned subsequently that, yes, there were a lot of things that the board was kept in the dark about, but the board also had all sorts of clues and signals about what was happening and didn’t pay attention to those because they really fell into this delusionary attitude that this was a superior company.

What are some of the red flags that something might be amiss?

I call it “keeping track of the lost signals” that exist all around. One of the questions I ask boards is: “Tell me about your early-warning system?” And I do not get very good answers. The most common answer that I get is, “Well, we look at our quarterly numbers and we see the trends and what’s happening.” And my response is, that’s kind of late in the game. If the problems are already playing out to the extent that they’ve hit the P&L and the balance sheet, you’re playing catch-up at that point. What are you doing to identify the problems that exist or potential problems that may exist ahead of time?

One of the biggest warning signs that companies need to be tracking is the extent to which key people in the organization are leaving. Yahoo is a good example: There’s been a steady flow of people out of Yahoo for a long time. Just the other day, some senior engineering/entrepreneurial types who had been acquired at an earlier time jumped ship. It’s a very powerful signal that something’s gone wrong.